Why the Stock Market is Still Screwed

Friday's GE bomb notwithstanding, the US
stock market has bounced off its lows, and bulls are triumphantly
proclaiming that we're off to the races again. (See, for example,
"DOW
20,000 in 12 Months") Before you embrace this conclusion,
however, consider the following:

In our experience, stocks don't normally go up on a sustained
basis until earnings estimates stop coming down. (Investors love
the "beating expectations" thing, and it's hard to beat
expectations when expectations are still absurdly high).

If the stock market has already entered the next cyclical bull
market, therefore, EPS estimates for the S&P 500 should be
low enough that even recession-pummeled companies can sail over
them.

Are they?

Sure as heck doesn't seem that way to us.

According to S&P (via
Bespoke Group), here are the "operating earnings" estimates
and year-over-year growth/decline for the S&P 500 for the
past two years and the next eight quarters ("operating earnings"
are a joke, because they don't include all the real losses that
American companies store up for a year or two and then take with
regularity, but we'll use them here to focus just on reported
operations):

ACTUALS:

QUARTER EPS
Y/Y

12/31/2005 $20.19 12%

03/31/2006 $20.75 15%

06/30/2006 $21.95 13%

09/30/2006 $23.03 22%

12/31/2006 $21.99 9%

03/31/2007 $22.39 8%

06/30/2007 $24.06 10%

09/30/2007 $20.87 -9%

12/31/2007 $15.22 -31%

ESTIMATES:

03/31/2008 $21.09 -6%

06/30/2008 $24.26 +1%

09/30/2008 $25.02 +20%

12/31/2008 $26.42 +74%

03/31/2009 $26.12 +24%

06/30/2009 $28.25 +16%

09/30/2009 $29.45 +18%

12/31/2009 $31.60 +20%

Let's see...two rough quarters to end 2007, a mild quarter to
start 2008...and then off to the races again! Specifically,
analysts think earnings will zoom ahead 20% in Q3, 74% in Q4, and
another 24% in Q109, hitting a level that is a full 20% higher
than the super-strong Q1 2007 two years earlier by early next
year. Ladies and gentlemen, this is what is known as a "hockey
stick."

Sometimes hockey stick growth projections make sense. Most of the
time, they don't. Given the troubles in the US economy--housing,
consumer spending, inflation, job losses, credit crunch--we are
very skeptical about the "second-half recovery" theory. Even if
there is a second-half recovery, moreover, we would be
flabbergasted if it produced the sort of earnings growth analysts
are still expecting.

More likely, in our opinion, analysts will be cutting their
estimates for at least another couple of quarters before
consensus projections finally hit bottom. Then, when earnings
finally recover, the recovery will likely be far more gradual
than analysts currently expect.

Why do we think so? In part because analysts are usually lagging
indicators. And in part because, in the last recession--one of
the mildest on record--the profits downturn lasted far longer
than the one that is currently projected, and the recovery was
far less rapid.

See for yourself:

QUARTER EPS
Y/Y

03/31/2000 $13.97 19%

06/30/2000 $14.88 13%

09/30/2000 $14.17 9%

12/31/2000 $13.11 -5%

03/31/2001 $10.73 -23%

06/30/2001 $9.02 -39%

09/30/2001 $9.16 -35%

12/31/2001 $9.94 -24%

03/31/2002 $10.85 1%

06/30/2002 $11.64 29%

09/30/2002 $11.61 27%

12/31/2002 $11.94 20%

03/31/2003 $12.48 15%

06/30/2003 $12.92 11%

09/30/2003 $14.41 24%

12/31/03 $14.88 25%

03/31/2004 $15.87 27%

06/30/2004 $16.98 31%

09/30/2004 $16.88 17%

See any 75% growth quarters? Neither do we.

Also note the time it took for earnings to recover (while bearing
in mind that this was a shallow recession): From the last
positive-growth quarter, Q3 2000, it took a full three
years for earnings to regain this quarterly level, let
alone exceed it by 20%. It wasn't until five years later
that earnings exceeded pre-recession levels by 20%. This compares
to the current expectation of a 2-year recovery.

And then there's the duration of the earnings decline. In the
mild recession of 2001-2002, earnings dropped year over year for
5 quarters, reaching a trough that was about 40% below the peak.
In the current recession, earnings are currently forecasted to
drop for three quarters and bottom only 15% below the
peak.

Still think analysts' current estimates reflect the most likely
reality? Still think earnings and the market are going straight
up from here?